Saturday, May 8, 2010

Risk ... what risk to the BP oil spill?

Dear Colleagues

The oil spill into the Gulf of Mexico should not really be a surprise ... the oil industry is one of the world's dirtiest industries, but most of the time the pollution the industry causes is below the radar because it is taking place far from the news media and in communities where local people are effectively disenfranchised both politically and economically.

The "risk" of something like this happening has been quite high for a long time ... and to their credit a spill of this magnitude has not taken place in the Gulf of Mexico. So now the question is how to handle the equitable allocation of cost to the responsible parties and the equitable distribution of compensation to those that have been affected.

What is the cost ... and who is going to bear the cost. Clearly BP as the beneficial owner of the well will pay to do operational things, including clean up operations. Hopefully there will not be some legal loophole that caps the amount of work that they need to do ... but do not be surprised to find some law that excuses them from doing the "right" things!

Hundreds of mile of wetlands are going to be affected ... thousands of square miles of ocean are going to be affected ... an area that is one of the most productive marine habitats in the world. The value destruction associated with damage of this magnitude to the ecosystem is not easy to quantify ... but a starting point at quantifying the value might be simply that it is likely to be about 5 times the market capitalization of BP just prior to the accident.

If someone had posed the question: "Would you prefer to have BP destroyed ... or the US Gulf Coast ecosystem destroyed?" any time in the last 10 years, I think that most people would have answered that they would prefer for BP to be destroyed. People do understand the biological importance of wetlands and the ocean ... even while they consume oil with total abandon!

The loss of livelihood for people living from the fisheries and all the shore based tourism and associated activities will be another substantial destruction of value. I do not have data about the affected population yet, but the value of the economic turmoil is a big number. It could easily impact the livelihood of 1 million people ... and it will change the economics of the seafood industry so that every restaurant in the country will have higher costs. The ripples will reach a long way into the economy.

The problem of risk is compounded because risk is "unfunded" ... almost all risk in the modern financial system is "unfunded" ... which simply means that all the costs of this mess are going to come out of some other part of the economy ... and in fact are going to land up higher costs, lower profits and eventually in fuel price increases just as soon as the market allows it.

Whether there is any silver lining in all of this is not yet clear. It should stimulate renewable investment ... and hopefully this will happen. This would be good for the planet.

But it is also likely to stimulate the search for and exploitation of natural gas. While natural gas burns more cleanly than coal or oil, it is not by any means a clean, safe product. The big "risk" associated with natural gas may well be the possibility that its extraction will result in massive pollution of the groundwater ... and in turn put America's drinking water supply at risk. This is a risk of cataclysmic scale ... yet not much talked about. Why would it be? Costing this risk into the exploitation of natural gas ... and setting aside the funds to mitigate this risk would end up making the whole idea totally uneconomic. Not exploiting natural gas maybe a very good decision for the country ... but very damaging to the corporate profit picture and the stockmarket! Migrating into widespread deep natural gas exploitation maybe is the biggest risk from the BP mess!

Risk is important. Value destruction from risk gone wrong is a big issue. We need to get it right!

About Me

Read engineering and economics at Cambridge ... qualified as a Chartered Accountant ... professional and corporate management working on management information and metrics of performance. International assignments as CFO and then as consultant to World Bank and UN agencies in connection with development projects and emergency situations. Work on planning at the national, area, sector and community level. Appalled at the current state of financial reporting in the corporate world and the metrics that drive major decisions in both the corporate and political sphere! The development of Community Analytics (CA) is a response to the need for better metrics than merely money accounting ... the concept of value should be treated with equal rigor and sophistication!